Cost Approach to Value
Cost approach to value is one of the approaches to value and is used for determining the value of a property. Other than this, there are also two other approaches to value and they are the income capitalization approach and sales comparison approach.
The cost approach to value is a set of procedures which helps in deriving a price indication for the fee simple interest in property and this is done by finding the estimate of current cost for constructing a replacement or reproduction of the existing structure that includes entrepreneurial incentive, addition of estimated land value and deduction of depreciation from total cost. After that, the indicated fee simple value of the property being appraised can be adjusted in order to get the valuation of the property interest that is being appraised.
Steps of cost approach
The cost approach has certain steps and the first of them is the estimation of the land value of the property. The estimation of the value of land is found by comparing the subject property with similar properties known as comparables and analyzing them. The next step involves estimating the costs of reproduction or replacement of all improvements. Then, the depreciation of improvement costs are made to get the value loss due to functional, external and physical causes. After that, the value indicator can be derived by the cost approach after adding the depreciated improvement costs to the land value.
The cost approach is based on the theory that the estimate of a property’s value can be made by adding the value of land and depreciated value of improvements. Often, the value of improvements is referred as RCNLD which means replacement cost new less depreciation or reproduction cost new less depreciation. Replacement cost means the cost to build a property with comparable utility but by making use of modern design, materials and workmanship. Reproduction cost means the cost of building an exact replica of the property. In most cases, replacement cost is used by appraisers from which depreciation is deducted.
The cost approach is most reliable when used on newer structures and special use properties like marinas, public assembly, etc, but for older structures, this method is not apt.